The latest shifts in sourcing and the current downturn aren’t just the business cycle doing what business cycles do—something fundamental has changed.
Countering the black cloud that tends to hover over talk about sourcing, Cheh said simply, “It’s not that sourcing is really driving retailers out of business, but it’s how you source and how you partner,” he said. “And the word I would emphasize is called collaboration.”
The notion of a new normal was coined by Mohamed El-Erian, then CEO of Pacific Investment Management Co. (Pimco), in the aftermath of the financial crisis a few years back, and as Cheh explained, the macro environment isn’t what it used to be.
There’s massive deleveraging, consumer buying behavior has changed and so has the policy environment.
What’s more, Cheh said, “There’s more government intervention, there’s need for more transparency and fundamentally, what needs to be done is transformation, innovation, technology, adaptation, structural change—those are really the buzzwords of the new normal.”
If you look at GDP growth year-on-year in major economies, recovery since 2011-12 has been sluggish. The U.S. and EU are all below 3 percent and Brazil and Russia are in negative territory, though India has enjoyed nearly 8 percent growth. In China, GDP growth has fallen from upward of 14 percent to sub 7 percent.
“This is global. No one is exempt,” Cheh said.
Looking more closely at China—which is ever the country guiding sourcing decisions, even if indirectly, Cheh explained that growth in the manufacturing industry has slowed and that the country is indeed shifting to more of a service economy. But what’s really dragging down China’s GDP growth is that investment, which had accounted for 7 percent to 8 percent of that growth, is now down to less than 3 percent.
However, as Cheh pointed out, an investment-driven economy that’s over-using its resources and investing in too much infrastructure or too much real estate, isn’t sustainable.
“So the new normal in China, at under 7 percent growth, also encompasses significant structural change—shifts in the consumption, rising income, less wasteful investment, technology innovation, transformation,” he said.
The apparel world has been quick to say that China is losing its competitiveness in the sector, but exports were down globally—not just in China—in 2015 and will likely be down again this year.
China’s growth in apparel sales reached as high as 30 percent a few years ago and is now roughly 6.7% percent (by comparison, clothing and accessories retail sales in the U.S. is down around -0.2% this year), so the pace—which may have been unsustainable anyway—has moderated, but the market is still growing.
“I think U.S. retailers and brands would be jumping up with joy if they were still enjoying 6 percent growth this year,” Cheh quipped.
In the world of the new normal, traditional brands like Ralph Lauren, Gap, J.Crew and Macy’s don’t see the sales success they once saw, and relative newbies like Amazon and Zalando have swooped in and shifted the distribution channel in favor of e-commerce.
Since 2008, e-commerce has doubled its share of the U.S. apparel market, now accounting for roughly 17 percent of sales. China, however, is enjoying the fastest e-commerce growth, at more than 31 percent, and the country’s e-commerce market is expected to be larger than that of the U.S. and EU combined by 2018.
“The whole market is changing,” Cheh said. “These are all parts and parcel of the new normal.”
Over the next decade, the industry will be driven by trends on the demand and supply side and shifts in the greater sector’s dynamics.
On the supply side, stretched supply and rising costs of labor and materials, like cotton, increasing scarcity of energy resources and water will shape the way forward, and on the demand side, factors affecting the future will include a slowdown in mature markets, vigorous growth in emerging markets and changing consumer consciousness and buying patterns.
So what’s the way to tackle all this?
With the new normal of suppliers’ competitiveness, Cheh said.
The questions suppliers should be asking themselves are, he said: “How do we persevere? How do we win? How do we provide better quality service and value to customers? Not just low prices. Not just talk about migrating to ever-lower labor cost countries. It’s how we combat the rising costs, how we transform, how we use technology and innovation.”
There are five C’s of suppliers’ competitiveness, according to Cheh: consolidation, creativity, cost containment, caring and conservation.
The market share of supplier countries has shifted.
In the quota days, China had as much as 13 percent of the U.S. apparel market. Post quotas, the country’s share swelled to a peak of 38 percent and now hovers around 32 percent. The fast growers—Vietnam, Indonesia and Bangladesh—have increased their market share since quotas, but Mexico with NAFTA, has a much smaller share of the market now than it did in the quota days. And India, despite its sizable capacity, has not seen its market share grow much at all.
“The point is, massive consolidation,” Cheh said. “The industry is consolidating not just in terms of market share, but also going vertical. From cut and sew to fabric to yarn to fiber. So the large players today are all doing that, and if you just look at garment manufacturing and you only look at the labor cost component of that, that is not the key driver anymore.”
China, with shifts in its economic structure and costs aside, still holds almost half of the world’s textile capacity.
It’s not enough to simply look at price anymore. Brands and retailers have to consider value, novelty, performance and functionality, and invest in R&D for more sustainable ways of manufacturing.
Esquel Group has worked to develop yarns that blend different natural fibers, like cotton silk, cotton wool and cotton cashmere, to create novel products. Cotton-based slim fleece for winter and a Vis-Dry garment that doesn’t show sweat or stick to the body are among some of its performance-based products.
Getting creative on cost competitiveness will also be vital.
Labor costs are going up everywhere in the world, and even rates in low labor cost countries won’t stay low for long.
But, as Cheh posed, “What’s wrong with rising labor costs?” Brands should not aspire to keep buying low-priced products on the backs of cheap labor, he said.
Looking at the total cost of production, labor generally accounts for just 25 percent or less. What companies need to consider now isn’t labor cost alone, but unit labor cost.
With unit labor cost (wages divided by output per labor), wages and output could both go up and unit cost will be flat. In the last few years, while the industry fussed about rising labor costs in China, the country’s unit labor costs have actually been flat.
“Only on the low value added products where labor is the highest component and fabric is a real commodity, then China is no longer competitive,” Cheh explained. “But it’s not because labor cost is too high, because we transform to make unit labor cost competitive. That’s the essence of competitiveness.”
Lean manufacturing will help, as will automation, technology innovation, RFID, wireless technology and the Internet of Things and factories. With automation and deskilling, complicated operations can be done perfectly with little training, higher productivity and higher income.
At Esquel’s latest high-quality spinning mill, 30,000 spindles require fewer than 40 operators to run the process, and robotic arms, precision positioning, aerial surveillance, garment self-assembly and packing automation, are all part of what make it possible.
Working hours at Esquel factories have gone down close to the daily 8-hour minimum and workers’ income over the last five to six years has doubled.
“That is the virtue,” Cheh said. “Higher wages mean higher income, means higher spending, means more dollars for buying apparel, and people are better off.”
Instead of looking at the supply chain as requiring boxes to tick for compliance, companies should care, train their employees, attract good people and lower the turnover rate.
Since spinning fabric is where the most water and energy is used, Esquel has focused on energy reduction per unit of output and water reduction per unit of output.
The company has also invested in sustainable cotton farming, solar energy and natural lighting, and enlisted industrial engineers to create structures designed to reduce energy consumption.
Esquel’s latest effort is a new industrial and tourism park concept going up in Guilin, southern China, and slated to open next year. There, deskilling and automation will be central to operations and R&D centers will live alongside the zero discharge, environmentally responsible garment factory and spinning mill to foster increased innovation.
Closing the keynote the way he began it, Cheh said brands’ and retailers’ success will rely heavily on how well they really partner with their suppliers.
In a world where shorter lead times are just as vital—if not more in some cases—as costs, suppliers would be better equipped to cut back on lead times if brands were better equipped to speed up their design and approval processes.
“If we have electronic data exchange on your sell-through data, we could position our raw material, we could have greige fabric ready for dyeing or finishing, we could have special yarn count ready to go and then bang, with that supply chain, we could deliver much faster,” Cheh said.
It’s all about a feedback loop.
“It’s not just order giving and order taking, that’s the old model,” Cheh said. “So we must collaborate. Quick replenishment is only possible if we work together.”